Trader Talk

Bernanke Speech Dominates Street Talk


My thoughts this Tuesday morning:

1) Ben Bernanke's speech widelydiscussed on the Street this morning. Traders wondering why he didn't talk about energy and food prices; further evidence that core inflation is what matters to the Fed. Not much about the weak dollar or inflation, but he did say we would take back some of the rate cuts "if inflation pressures proved stronger than expected." He did acknowledge that housing would be a drag on the economy into early next year.

Nothing specific on what he plans to do in the next 2 FOMC meetings, but we certainly now know that Bernanke's emphasis is on the economy, not inflation.

2) Ericsson's surprise profit warning is having a ripple effect in the entire telecom sector; Alcatel Lucent, Motorola and Nokia are all down pre-open. They blame shortfalls in network and software upgrades--customers not upgrading like they thought. Remember Alcatel Lucent warned in September.

3) More poor comments from banks, this time from regional bank KeyCorp . Profits were below expectations, hurt by loan losses and volatility in fixed income. Wells Fargo also missed expectations, by a small amount ($0.68 actual vs. $0.70 expected). US Bancorp beat by a penny, but they too talked about stress in the mortgage banking business.

4) The weakness in financials yesterday due to Citi's comments about increasing reserves for possible losses on the consumer side has revived fears that some of the pillars of owning financials in Q4 might not be as sturdy as some traders thought.

Late yesterday, Goldman Sachs' David Kostin went right at this argument, attacking four "myths" about financials. Below are excerpts from his report:

(1) Myth: Financials always outperform when the Fed cuts interest rates.

Truth: Financials beat the S&P 500 on average when the Fed lowers rates. But we believe the 1989 experience is most analogous to today's situation. Financials underperformed by 25 percentage points after easing started.

(2) Myth: Financials benefit from strong international trends.

Truth: Financials has among the lowest foreign market exposure of any sector. Only 3 Financials firms generate more than 50% of revenues from outside the US. Median stock in sector has 2% non-US revenue exposure.

(3) Myth: Valuation is extremely attractive for Financials.

Truth: Financials trades at fair value on average.

(4) Myth: Bad 3Q results are already priced in because Financials stocks are trading up on the day negative news is announced.

Truth: We believe Financials will underperform if companies continue to post negative surprises and lower earnings guidance. Current 2008 earnings growth expectation for Financials is 10.2% despite the disappearance of many mortgage-related businesses that contributed to stellar EPS growth in recent years until summer 2007. Mortgage origination fees, servicing fees, and revenue from the securitization and sale of loan commitments for LBOs all seem likely to be less in 2008 than in 2007, but estimates do not reflect this fact.

He recommends investors underweight the sector.

Questions?  Comments?